What will the Fed do in 2023?

Fed hikes slow but will probably go higher

While this week's Federal Reserve meeting went mostly as expected, policymakers had at least one surprise: They raised their projections for inflation despite recent encouraging news on rising prices, according to Goldman Sachs Research.

The Federal Open Market Committee raised its fed funds rate by 50 basis points and increased its projection of the peak rate in 2023 by 50 basis points to 5-5.25%.

Our economists continue to expect three additional rate hikes of 25 basis points each in February, March and May, for a peak funds rate of 5-5.25%. “We see the FOMC's overriding goal as continuing what it has successfully begun in 2022: maintaining a below-potential growth pace that steadily narrows the jobs-workers gap,” economist David Mericle wrote in the team's report.

The FOMC's median inflation projections rose to 3.5% (+0.4 percentage point) in 2023 and 2.5% (+0.2 percentage point) in 2024. Fed Chair Jerome Powell clarified that the projections reflected the softer-than-expected consumer price index (CPI) report for November.

Will the Inflation Reduction Act get us to net zero? 
The U.S. Inflation Reduction Act (IRA), a sweeping climate, healthcare and tax bill, was signed into law earlier this year. Senior leaders from Goldman Sachs discuss what the bill means for the U.S.'s decarbonization goals:
  • The IRA provides almost $400 billion of energy and climate spending over a 10-year period, according to the U.S. Congressional Budget Office, with about $270 billion of that coming in the form of new tax incentives for businesses and individuals to pursue and invest in cleaner and more efficient energy sources.  
  • The world needs to see $1.8 trillion more in annual investment this decade to reach net zero by 2050, according to Brian Singer, the global head of GS SUSTAIN within Goldman Sachs Research. The IRA provides new incentives estimated by the government to average $27 billion a year over the next decade, though this is not an upper limit. Singer says it will “push forward the deployment of clean energy solutions.”  
  • Rebecca Kruger, a managing director in the Natural Resources Group within Goldman Sachs Investment Banking, says the IRA is “significant” for some of the energy companies she advises. For many companies, she says, the bill is “shifting the world view on the art of the possible.”  
  • Akif Irfan, a portfolio manager on the energy infrastructure and renewables team in Goldman Sachs Asset Management, says it's not simply the tax credits that stand out about the IRA, but the clarity the bill provides around those credits. "In some cases some tax credits have been extended for a decade or longer,” he says. 
  • “The IRA won't get us to 100% on U.S. net-zero goals, and it's hard to picture any piece of legislation sitting here in 2022 that would have gotten us to a fully decarbonized economy,” Kruger says. “But this does move us significantly in that direction.” 

Finding opportunities in emerging market bonds
Debt loads have risen sharply in emerging markets this year because of government responses to the pandemic and surging inflation. As a result, two emerging market debt experts at Goldman Sachs Asset Management say some developing nations will struggle to raise capital in the coming year. But others appear more resilient and have large stockpiles of foreign currency. More broadly, the experts see opportunities through active management to earn higher investment returns in a new era for financial markets — one in which easy monetary policy is no longer lifting all assets. 

The outlook for US financial services
Banks are often seen as a bellwether for the economy — so what do they tell us about the U.S. economic outlook? In the latest episode of Exchanges at Goldman Sachs, Goldman Sachs Research's Richard Ramsden and Alex Blostein discuss the state of indicators like lending, credit quality and liquidity, the implications of higher inflation and rates, asset allocation trends and the outlook for capital markets activity after a muted 2022. They also share the themes that were in focus at the recent GS U.S. Financial Services Conference.
Above (L to R): Alex Blostein, Richard Ramsden and Allison Nathan of Goldman Sachs. 
  • Tightening credit quality. “At the margin, banks are starting to tighten underwriting standards,” Ramsden tells Exchanges host Allison Nathan. “Rather than pulling back in terms of availability of credit, I think what most banks are doing is adjusting the price of that credit or the price of that loan to really compensate them for what they perceive the economic risk to be.”
  • Inflation impact. “Very simply, inflation has resulted in more loan demand over the last few years. So, as an example, if you go out and buy a used car today, it's probably going to cost 20% to 30% more than three years ago. Which means that the size of the loan is 20% to 30% larger than a few years ago,” Ramsden says. “There's a lot of focus around how inflation could impact credit quality, especially at the lower income cohorts for households.”
  • Focus on portfolio construction. “When we pivot to '23 and perhaps longer — with a less accommodative Fed policy — you could see much more focus on downside protection. I think probably more search for alternatives. And more ways to look for uncorrelated assets,” Blostein says.
  • Pick up in M&A? “One of the themes we've heard loud and clear from a number of large private equity firms is that the appetite for public-to-private transactions is definitely starting to pick up for the first time in quite a long period of time,” Blostein adds. “We're likely to see more public-to-private transactions. So that will help the M&A backdrop.”

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